Why interest rates can’t move, won’t move

Nigeria’s Central bank has held its policy interest rate at 12 per cent for the 12th consecutive month. Can anything make it budge?

Analysts seem to think not. There are three factors that will keep rates locked: inflation, the naira and reserves.

First, inflation has fallen from double digits to under 8.2 per cent in August – well below the target limit of 10 per cent and a five-year low. That gives scope for a cut, surely?

Perhaps, but as Shilan Shah of Capital Economics pointed out: “The big falls in the headline CPI rate now look to have taken place… inflation is more likely to rise than fall in the coming months.”

So that’s one reason to keep rates steady.

The main concern for policy makers, though, is the naira. Like many emerging market currencies, it has lost value since May as investors feared the Fed would – as it suggested – begin tapering its QE programme, and has rallied since that prospect became more distant last week. The naira hit a year-to-date low against the dollar of 164 on September 10, but has since recovered to back under 160. That has eased any pressure for a rate increase.

The central bank has been using its foreign reserves to help keep the naira around or below the 160 mark. Add the consequent depletion in reserves to the possibility of falling oil prices and increased public spending in the run up to elections in 2015, and the budget deficit – of around 3.5 per cent of GDP – starts to become a concern.

As Razia Kahn, Africa economst at Standard Chatered said in a note:” Should the pressures on the FX rate prove excessive, we may yet see other measures aimed at stabilising the FX rate. For Nigeria, the question is about sustainability of this FX policy, given pressures on oil output and the country’s political cycle.

What might those other measures be? Well, back in July the bank hiked its Cash Reserve Requirement for public sector deposits in banks to 50 per cent from 12 per cent, a move aimed at removing excess liquidity and, by putting upward pressure on bond yields, strengthening the naira.” Barclays set out the scale in a note back in July: “Our assessment suggests the government’s (federal, state and local) deposits are substantial, accounting for about 21% (NGN2.5trn or $16bn) of commercial banks’ deposit liabilities as of March 2013. A 50% reserve requirement would imply about $8bn would now need to be held at the central bank, assuming zero holding in these categories currently and little changes from the figures published in March.” Meanwhile, banks’ deposits at the central bank held for reserve requirement purposes totalled NGN1.4trn ($9.1) in March.

And Nigeria continues to make strong statements about the currency. Here is central bank governor Lamido Sanusi, quoted on Tuesday by Bloomberg: “We don’t believe that there’s any country in the world that would allow its currency to be determined by markets.”

That’s not quite the message of recent currency moves and foreign exchange dealings, as beyondbrics reported on Monday.

But with Nigeria’s central bank mindful of inflation as well as the naira, the scope to cut is limited. Although Capital’s Shah suggested that rates may stay on hold for all of 2013 and beyond, Kahn noted that “the performance of the currency will likely determine what happens next.” Another round of EM currency selling will put the bank in a tricky position.